Chinese debt a major risk to Australia, says RBA governor Philip Lowe

By Peter Martin & Jennifer Duke

Updated23 May 2018 — 7:06pmfirst published at 6:59pm

Reserve Bank governor Philip Lowe has pointed to the build-up of debt and bad loans in China as one of the biggest risks facing the Australian economy, noting similar situations in the past have led to a slowdown in growth or financial crisis.

“Perhaps the single biggest risk to the Chinese economy at the moment lies in the financial sector and the big run-up in debt there over the past decade,” he told a forum at the Australia-China Relations Institute (ACRI) in Sydney on Wednesday night. “Among the largest economic risks that Australia faces is something going wrong in China.”

China was not only the main destination for Australia’s iron ore and coal but had become the largest destination for a range of food and service exports. Chinese tourists accounted for one quarter of all the tourist dollars spent in Australia, and Chinese students for one third of all education exports. Service exports to China exceeded those to the United States and Britain combined.

Philip Lowe, governor of the Reserve Bank.

Photo: Bloomberg

The Reserve has more staff looking at China than any other single overseas economy, including three staff based in Beijing. So concerned is it about the risk inherent in the build-up of Chinese debt that it convened a special discussion on the topic at its May board meeting.

“Not surprisingly, addressing this risk has become a priority of the Chinese authorities,” Dr Lowe told the forum. “We all have a strong interest in their efforts being successful.”

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China fought off the global financial crisis through a massive boost in infrastructure and construction spending, financed almost entirely by Chinese households through the government-controlled financial system. Its debt to GDP ratio ballooned from 100 to 260 per cent of gross domestic product, the biggest increase of any major economy and one of the biggest burdens in the world.

“The experience is that the build-up of financial risks like those seen in China is almost always followed by a marked slowdown in GDP growth or a financial crisis,” Dr Lowe said. “It is important to point out that these outcomes are not inevitable and that China is able to learn from theexperience of other countries, including Australia. Even so, it is understandable that concerns have been raised.

“One of these concerns is that during the big run-up in debt, a lot of bad loans were made. Rapid credit expansion supported excess capacity developing in some heavy industries, with large loss-making enterprises kept afloat with additional borrowing.

“It is not unreasonable to suggest that many of these loans would have failed to meet credit standards in other banking systems.

“Another concern is the growth of the so-called ‘shadow banking’ system. Non-bank financing now accounts for 45 per cent of total debt, up from 25 per cent a decade ago. The complex is characterised by opaque risk transfers, implicit guarantees and complex connections.

“To the extent that experience elsewhere in the world is any guide, it is difficult to escape the conclusion that this complex web in a highly indebted economy is a risky situation.”

“It is too early to tell whether the authorities will be successful in managing the transition from a growth model heavily dependent upon the accumulation of debt to one where credit is less central. It is a very significant task. The experience of other countries suggests caution and, elsewhere, there have been serious accidents along the way.”

A stable and robust Chinese financial system was clearly in Australia’s interest.

"As the economic relationship between our two countries broadens and deepens, developments in China are having a material impact on more and more Australian industries," Dr Lowe said. "It is important that we have a thorough understanding of one another."

Despite the concerns raised, former premier of NSW Bob Carr, director of the ACRI, said that if Mr Lowe were to do the same talk three years ago, “the first question would be is China heading for a soft landing or a hard landing?”

“What’s noteworthy for me is when you talk, say to people in Hong Kong, about Chinese economic prospects now it doesn’t come up,” he said.

Dr Lowe agreed the skepticism and pessimism some people had about China had been “misplaced” as authorities had managed to keep the economy on a reasonable growth trajectory that he was confident they’d continue.

“They are addressing the vulnerabilities of the financial system before the problems actually arise,” he said.

He had also seen a move towards transparency in the financial sector, with the Chinese government being “very clear about their agenda” and officials were being more open about discussing issues.

“There’s more work to be done but moving in the right direction,” he said.

He described the RBA’s relationship with the People’s Bank of China as “very strong” but would not comment at the political level.

“Like in all relationships, there are going to be ups and downs ... It's happened in our relationship with the US periodically as well.”

Peter Martin is the economics editor of The Age, based at Parliament House. A former Commonwealth Treasury official with an honours degree in economics, he has reported economics for the ABC and then Fairfax Media since 1985.